How The IRS Picks Its Audit Targets

The IRS doesn’t just draw potential audit victims out of a hat. There is actually a method to its cruel madness, as outlined in this 2006 IRS.gov post spotted by Jim Wang of Bargaineering.

Wang highlighted four of the chief audit-hunting processes:

* Computer Scoring – I listed this one first because it’s the most interesting of the four reasons. Tax returns are “scored” using two systems – Discriminant Function System (DIF) and Unreported Income DIF (UIDIF). The Discriminant Information Function System (DIF) score gives the IRS an indication of the potential for change in tax due, based on past IRS experience. The Unreported Income DIF (UIDIF), as you can imagine, scores the return on the potential for unreported income. The higher the score, for either, the more likely the return will be reviewed.

* Information Matching – This is an obvious reason because it’s the easiest to catch. The IRS receives the same W-2s and 1099s that you do, so it’s trivial for them to compare the two totals. If they don’t match, they investigate.

* Related Examinations - Beware who your friends/business contacts are! If their returns are audited and their return includes transactions with you, your return may be audited as well.

* Potential participants in abusive tax avoidance transactions – The IRS may get information about promoters of and participants in various schemes and select a return for audit based on that information.

Hey, tax experts — what potential audit-drawing red flags do you think readers should watch out for?

How Does the IRS Pick Tax Returns to Audit? [Bargaineering]